Don’t Go Full-On Bull Just Yet

A significant drop in the trade deficit and a comment from the Boston Federal Reserve Bank that the Fed should only “gradually” cut back on its bond-buying plan sent stocks higher Tuesday.

The broad rally was also helped by better economic data from Germany. Euro zone inflation was reported to have fallen from 0.9% in November to 0.8% in December, which could mean that the European Central Bank (ECB) may have to embark on an easier money strategy than expected for the first part of this year.

At the close, the Dow Jones Industrial Average rose 106 points to 16,531, the S&P 500 gained 11 points to 1,838, and the Nasdaq jumped 40 points to 4,153. Total volume on the NYSE was 3.5 billion shares, and 2.3 billion traded on the Nasdaq. Advancers outpaced decliners by 1.9-to-1 on the Big Board and by 2.3-to-1 on the Nasdaq.

Tuesday’s 100-plus-point rally may be “just what the doctor ordered.” After three days of modest declines, this rally puts the ball back in the bulls’ court. The support at 16,425 has held in that Tuesday’s close was higher than every close since the absolute closing high at 16,577 on Dec. 31.

If the Dow reverses back down, there is still strong support at 15,720 to 16,100. Within that band is the 50-day moving average at 15,986. A test of the low of the band would result in a 4.9% decline from Tuesday’s close.

The Dow Jones Transportation Average does not contain the same bullish pattern as the industrials. Tuesday’s advance of 54 points with a close at 7,288 only managed to exceed Monday’s close, and thus did not change the extreme near-term downtrend that began on Jan. 2.

Support at its 20-day moving average held, but the MACD indicator flashed a sell signal and has resided in bearish territory for two days.

Conclusion: Based on the price action of the two Dow indices, the industrials and transports, we are faced with a possible Dow non-confirmation. That condition could turn positive if the transportation average can break the five-day pattern of lower highs and lower lows.

But Tuesday’s upside volume versus downside volume on the NYSE failed to reach a positive 2-to-1, and breadth was at just 1.9-to-1 — not a solid indication that a quick reversal and breakout are about to occur. And with MACD residing in the negative zone, it is best to stand aside for now and let the market work out its contradictions before we plunge back into a fully bullish stance.

Food for thought: BlackRock Global Chief Investment Strategist Russ Koestrich appeared on CNBC Tuesday morning and made the following observations:

1. The trailing P/E of the S&P 500 is about 17 times earnings.

2. Earnings are expected to increase by about 5% in 2014, and total return (including dividends) could add another 2%.

3. The debate over the debt ceiling, which begins on Feb. 7, is of concern.

4. Small caps will not grow at the rate of last year because of increasing interest rates, and so BlackRock favors large-cap stocks versus small caps. Also, large caps have lower P/E multiples.

5. Finally, he said to stay away from bonds and bond equivalents like utility stocks and buy technology, energy and industrial stocks.

Tomorrow, I’ll consider Koestrich’s observations in calculating a possible target for the S&P 500 in 2014.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[2].